Lawrence Summers, Axel Weber, Mervyn King, Ben Bernanke, Olivier Blanchard at the LSE: "I Do Not Believe the Long Run Can Be Ceded to the Avatars of Austerity" Weblogging

I think you got it right when you spoke of allowing people to have higher living standards and more choices in their lives and to live more comfortably. I cannot resist taking the opportunity, though, to disagree with the broad spirit of Axel [Weber's] last comment. I do not believe that the long run can be ceded to the avatars of austerity.

I am the father or stepfather of six children. Yes, on their behalf, I am concerned about the possibility that an overly inflationary psychology will develop in my country. Yes, on their behalf, I am concerned that an excessive debt not be placed upon them.

But I am vastly more concerned, because I care about their long-run future, that a slack economy will not provide them with adequate jobs when they leave school. I am vastly more concerned, on behalf of their long-run future, that they will live in a country with decaying infrastructure that will not permit investment to maintain leadership. I am more concerned on their behalf that inadequate resources forced by countercyclical austerity will stunt the ability of their generation to be educated. I am more concerned, on their behalf, that excessive austerity-oriented policies will lead to slower economic growth, and as a consequence to ultimately higher debt-to-annual-GDP ratios--and more pressure, in terms of higher tax burdens, on the future.

Those concerns, which come out of the improper management of current conditions, seem to me to be a larger issue especially for the long run than the concern that somehow unstable and overly expansionary policy starting from where we are now will stunt the opportunities that are open to them.

Now, of course, if policy were starting from a different place I would reach a different judgment.

But starting from where the United States or much of Europe or much of the rest of the industrialized part of the world is starting today, the risks of profound stagnation are a more pressing concern than the risks of a resurrection of stagflation.

It seems an extraordinary imbecility that this wonderful outburst of productive energy [over 1924-1929] should be the prelude to impoverishment and depression. Some austere and puritanical souls regard it both as an inevitable and a desirable nemesis on so much overexpansion, as they call it; a nemesis on man's speculative spirit. It would, they feel, be a victory for the mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy. We need, they say, what they politely call a 'prolonged liquidation' to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again.

I do not take this view. I find the explanation of the current business losses, of the reduction in output, and of the unemployment which necessarily ensues on this not in the high level of investment which was proceeding up to the spring of 1929, but in the subsequent cessation of this investment. I see no hope of a recovery except in a revival of the high level of investment. And I do not understand how universal bankruptcy can do any good or bring us nearer to prosperity...

Notes on Presentations:

Tim Besley: Introduces Mervyn King, the Moderator, stepping down later this year from his position as Governor of the Bank of England

Mervyn King: What to do? First, don't start from where we are. Financial crisis, euro crisis, fiscal crisis--all are far from over. Peter Diamond: "on any given subject there are at most only three papers you need to read. The trick is to know which the three are. Tonight we need more than three--we need four: Fed Chair Ben Bernanke, IMF Chief Economist Olivier Blanchard, Former Treasury Secretary Larry Summers, and UBS Chair Axel Weber.

Ben Bernanke: A classic financial crisis in the novel institutional context of "shadow banking." One of the few bright spots was international cooperation. Today: I will talk about "currency wars". Are we engaged in a "currency war"? No. Cf. Eichengreen and Sachs (1986). North Atlantic economies currently doing what they should be doing, and should not be seen as engaged in trade diversion.

Olivier Blanchard: "If Mervyn, Ben, and others had not been there, we would be in much worse shape today." Humility is in order. The Great Moderation had convinced too many of us that large crises were a thing of the past, confined to emerging markets only--if them. My generation lived with the notion of progress, and that we knew how to do things better and better. That's not true. History repeats itself. The financial system matters very much. After the Oil Shock, we concluded that we could analyze supply shocks by just adding on a piece to our standard macro model. This is different: what we have learned is that you have to understand the plumbing. Before I came to the IMF I thought of the financial system as a set of arbitrage equations modulus small and slow-moving risk premia. What we have learned is that that is just not the case. This financial crisis shows the limits of macro. Interconnectedness. We need not just monetary policy and fiscal policy but banking policy. Reaching for yield when interest rates are very low is a threat. How should central banks use prudential banking and monetary policies? How independent should central banks be?

Lawrence Summers: Economics seeks to understand a changing world whose functioning is changed by economic thought. The restructuring of macroeconomics: Macro used to say: comparative statics ruled--economies jump from equilibrium to equilibrium quickly as conditions change. That is clearly wrong. Independence of trend and cycle--good macro policy simply reduces volatility. That too is clearly wrong. Good macro policy boosts growth as well.

The restructuring of central banks: We used to focus on the importance of prudent inflation-averse central bankers. Now that is a sideshow. We focus on other things. We used to talk about the difference between liquidity and solvency crises. But if your solvency is not in doubt, you cannot be illiquid--central banking takes on credit risk by necessity in executing its lender-of-last-resort function. And that raises questions. There are the questions of the interactions between monetary and fiscal policies--expansionary monetary policy turns into sectoral policy aimed at favoring sectors that produce high-duration instruments. The knotty question of the proper maturity of the debt, and who makes them. Targets and instruments: as the aspiration for the number of kinds of problems central banks are supposed to avoid proliferate, they need more instruments, and yet the additional instruments are very much of political concern. Isolating central banking from politics becomes impossible…

Axel Weber: The Cypriot developments are a reminder that there still remain complex risks, and maybe our increased optimism was too good to be true. Asset price rises are still driven by excessively easy monetary policy. Fiscal and structural problems are still untackled. Fundamentals are still not good. Hugely elevated and unprecedented debts and deficits. What will an orderly exit look like? Central banks cannot resolve structural reforms. There is a necessary debate over whether the time bought by quantitative easing was used wisely. Does quantitative easing simply delay necessary structural reforms? Central banks need to weigh whether these policies will not cause bigger problems down the road.

The key role of central banks as single supervisors should not lead to a diversion of central banks from their core mandates. The focus of central banks could get lost. Not clear that monetary policy and banking supervision should be under one roof.

In a double- or triple-dip scenario, demanding that banks deleverage as fast as we had planned in 2009-2010 may be very unwise.

Q&A:

Mervyn King: Ben, how would you reconstruct macroeconomics?

Ben Bernanke: Bringing financial markets in is critical. In some ways, the reconstruction is what I was doing: Bernanke-Gertler, etc. But Olivier's point that the details matter a lot is really important. The decline in wealth associated with the bursting tech bubble and with the bursting housing bubble through 2008 were about the same. Yet the housing bubble was much more damaging because it broke the credit-mediation system because of overleverage. To understand that, you really need to understand the details of exposure in ways that the banks did not themselves understand at the time.

Olivier Blanchard: We need to separate the interest rate that is in the IS Curve and in the LM Curve. This is the one message that I would communicate to undergrads. At the graduate level--we have this explosion of DGE models with frictions. Two are key: leverage and liquidity. At the moment we don't understand our modes: they have too much in them.

Axel Weber: Too little view of systemic risk. Too many banks where the people buying the securities did not talk to their own people who were selling similar securities.

Larry Summers: I was tempted to blast off at DSGE. But what is it that wouldn't be a DSGE? A SCPE model. It is hard to see how that would be an improvement. Is macro about--as it was thought before Keynes, and came to be thought of again--cyclical fluctuations about a trend determined somewhere else, or about tragic accidents with millions of people unemployed for years in ways avoidable by better policies. If we don't think in the second way, we are missing our major opportunity to engage in human betterment. And inserting another friction in a DSGE model isn't going to get us there. Now it is easier to criticize than to do. But multiple equilibria, fragile equilibria, and so forth have promise. A little bit of avoiding what's happened over the past six years would have paid enormous dividends…

Five years on, the global economy continues to come to terms with the impact of the financial crisis. This event examines the lessons that both economists and policymakers should learn in order to lessen the chance of future crises.

I think you got it right when you spoke of allowing people to have higher living standards and more choices in their lives and to live more comfortably. I cannot resist taking the opportunity, though, to disagree with the broad spirit of Axel [Weber's] last comment. I do not believe that the long run can be ceded to the avatars of austerity.

I am the father or stepfather of six children. Yes, on their behalf, I am concerned about the possibility that an overly inflationary psychology will develop in my country. Yes, on their behalf, I am concerned that an excessive debt not be placed upon them.

But I am vastly more concerned, because I care about their long-run future, that a slack economy will not provide them with adequate jobs when they leave school. I am vastly more concerned, on behalf of their long-run future, that they will live in a country with decaying infrastructure that will not permit investment to maintain leadership. I am more concerned on their behalf that inadequate resources forced by countercyclical austerity will stunt the ability of their generation to be educated. I am more concerned, on their behalf, that excessive austerity-oriented policies will lead to slower economic growth, and as a consequence to ultimately higher debt-to-annual-GDP ratios--and more pressure, in terms of higher tax burdens, on the future.

Those concerns, which come out of the improper management of current conditions, seem to me to be a larger issue especially for the long run than the concern that somehow unstable and overly expansionary policy starting from where we are now will stunt the opportunities that are open to them.

Now, of course, if policy were starting from a different place I would reach a different judgment.

But starting from where the United States or much of Europe or much of the rest of the industrialized part of the world is starting today, the risks of profound stagnation are a more pressing concern than the risks of a resurrection of stagflation.